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Performance review
Operations
North America Market
The Group’s activities in North America centre around two main market areas – plumbing and heating distribution, which are served by Ferguson and Wolseley Canada, and building materials distribution, which is served by Stock. Ferguson and Wolseley Canada have now been integrated to bring a more strategic approach to plumbing and heating distribution at a North American level.
Ferguson is the largest wholesale distributor of plumbing supplies, pipes, valves and fittings in the USA and a major distributor of heating, ventilation and air conditioning systems1. The company also distributes waterworks products, fire protection products and industrial pipes, valves and fittings as well as operating a number of speciality businesses, serving markets such as the nuclear industry and a maintenance, repairs and operations management services business. Ferguson is managed through ‘business groups’ such as Heating Ventilation and Air Conditioning (‘HVAC’) and Waterworks. These business groups allow management to focus on the specific needs of key groups of customers. Ferguson is present in 50 states, as well as the District of Columbia and has 1,417 branches (2006: 1,237 branches).
Wolseley Canada distributes plumbing, heating and piping products, including heating, ventilation and air conditioning, waterworks, refrigeration, industrial pipes, valves and fittings and fire protection products as well as industrial plumbing supplies to customers through its 260 branches (2006: 246 branches).
Stock is the second largest supplier of building materials to professional home builders and contractors in the USA2. Stock is present in 33 states with 308 locations (2006: 314 locations) and provides contractors with building materials such as structural timber products, roofing materials, doors, windows, insulation and hardware. Stock also assembles and sells a variety of engineered wood products including roof trusses, and offers customer delivery, design and installation as well as financing and credit services.
In general, the North American plumbing and heating distribution market is fragmented with an estimated 95 per cent of distribution operations employing less than 100 people. Consolidation of market players has accelerated with some of the major retailers having moved more significantly into the market. The North American building materials market is also very fragmented.
Both markets have been impacted in the year by weakness in the new residential sector of the market which has been affected by an oversupply of new homes, rising interest rates and sub-prime mortgage default issues. Despite this, Ferguson has shown good organic growth outperforming the market and gaining market share. Although Stock’s revenue declined, it also outperformed its market.
Demographic trends support high rates of home ownership and residential construction in the long-term with ‘baby boomers’ entering their peak earnings time and purchasing second or trade-up homes. Baby boomers, who are thought to control a majority of the wealth in the USA, are also expected to have a significant effect on the repair and remodel market as their decision to improve their existing homes will be less influenced by the state of the economy.
The plumbing and heating distribution market is driven by new construction and remodelling sales. The latter market is less cyclical. The building materials market is influenced similarly although Stock’s business is currently more focused on the new residential construction sector and has therefore been significantly affected by weakness in that market in the year, as well as by lumber and panel commodity prices which have declined in this period of weak demand. Annualised housing starts in the USA at 31 July 2007 were 1.37 million per annum3, compared with just below 1.8 million per annum at 31 July 2006.
Splitting the US into four geographic regions and using US Census information (for housing starts) and estimates provided by North America’s Home Improvement Research Institute (for remodelling), it is possible to analyse the split and growth or decline in activity of new housing and remodelling by region. This can then be compared to Wolseley’s share of its business in each of these regions although it should be noted that this also includes some revenue from non-residential sources.
1Source: Supply House Times, May 2007
2Source: ProSales, 2007
3Source: US Census Bureau
£bn
| New residential | Remodelling | Wolseley | |||
|---|---|---|---|---|---|
| Region | Calendar 2006 share of starts |
Decline versus 2005 |
Calendar 2006 share |
Growth versus 2005 |
Share of revenue in 2006/7 |
| Northeast | 9.3% | (11.9)% | 17.3% | 7.8% | 7.5% |
| Midwest | 15.5% | (21.8)% | 23.0% | 6.2% | 15.6% |
| South | 50.5% | (8.6)% | 36.0% | 9.1% | 46.5% |
| West | 24.7% | (15.4)% | 23.7% | 8.6% | 30.4% |
Note: New residential and remodelling information relates to calendar years whereas the Wolseley information relates to the year ended 31 July 2007.
In the South and West areas which in 2006 represented 75.2 per cent of new housing starts and 59.7 per cent of remodelling activity, the division had 76.9 per cent of its business and hence is well placed to exploit these key markets.
Management has estimated overall market sizes for North America. For the materials market, market size is based on the final selling cost to the installer or end user. For construction services, the market only includes those activities currently serviced by Wolseley. Management’s best estimate of both Wolseley’s activity in each market and the total size of these markets are set out below:
| Wolseley North America | USA | Canada | |||||||
|---|---|---|---|---|---|---|---|---|---|
| Sales £bn |
Estimated market size £bn |
Estimated market share % |
Sales £bn |
Estimated market size £bn |
Estimated market share % |
Sales £bn |
Estimated market size £bn |
Estimated market share % |
|
| Plumbing, heating and | |||||||||
| air conditioning | 3.3 | 32.8 | 10% | 2.9 | 27.6 | 10% | 0.4 | 5.2 | 8% |
| Electrical | 0.1 | 36.9 | 0% | 0.1 | 30.3 | 0% | – | 6.6 | 0% |
| Building materials | 2.2 | 162.5 | 1% | 2.2 | 148.6 | 1% | – | 13.9 | 0% |
| Civils/waterworks, industrial | |||||||||
| & commercial | 2.8 | 106.7 | 3% | 2.6 | 102.7 | 3% | 0.2 | 4.0 | 5% |
| Construction services | 0.3 | 77.3 | 0% | 0.3 | 57.8 | 1% | – | 19.5 | 0% |
| Total | 8.7 | 416.2 | 2% | 8.1 | 367.0 | 2% | 0.6 | 49.2 | 1% |
Management has also estimated the business drivers for its revenues in a consistent manner to the European division. The results are shown below:
| Sales £bn |
% Sales | |
|---|---|---|
| Residential: | ||
| New construction | 3.4 | 38% |
| Repairs, maintenance and improvements | 1.3 | 15% |
| Non-residential: | ||
| New construction | 2.1 | 25% |
| Repairs, maintenance and improvements | 1.1 | 13% |
| Civil Infrastructure | 0.8 | 9% |
| Total | 8.7 | 100% |
US plumbing & heating US$m
US building materials US$m
In general the division shows a broad spread of business across the categories. While residential new construction has declined, the other segments continue to show growth. Actions are being taken to widen the Group’s North American business base and increase Wolseley’s presence in these other market segments. The use of the business group model providing dedicated focus on customer segments in North America is assisting progress towards this objective.
Wolseley remains confident that with the continued development in the strength and depth of its management and the investment being made in the supply chain, the business is well placed to outperform in its markets and succeed in meeting its growth targets and improving margins over time.
Divisional performanceThe North American division performed well ahead of a market which was significantly impacted by a slowdown in the new housing sector, maintaining its position as the leading distributor of construction products to the professional contractor in North America.
Reported revenue, in sterling, of the division decreased 3.8 per cent to £8,662 million (2006: £9,008 million), reflecting the 8.1 per cent negative impact of currency translation and an organic revenue decline of 4.6 per cent, partly offset by acquisitions. Trading profit, in sterling, declined by 19.2 per cent to £487 million (2006: £603 million), after charging £12 million of one-off costs relating to headcount reductions and branch closures. Currency translation reduced divisional revenue by £726 million (8.1 per cent) and trading profit by £49 million (8.1 per cent).
The North American operations are being increasingly integrated with a number of central functions now supporting all three businesses. Since 1 August 2007, Wolseley Canada has been integrated into Ferguson, operating with the same business structure which focuses on specific customer types, and will benefit from leveraging the US operations, including the DC network. There has been a particular focus to reduce aggregate corporate costs across the North American businesses and functions and these have declined by 8 per cent. There was a net increase of 188 branches in North America to 1,985 (2006: 1,797). Two new DCs in Frost Proof, Florida and Stockton, California are scheduled to be opened before the end of the 2008 financial year, adding more than one million square feet of space to the North American DC network.
In the USA, the new residential market continued to be challenging, but the RMI market and the commercial and industrial sectors continued to provide opportunities for growth. Aggregate revenue, in dollars, from the Group’s US businesses, including acquisitions, was 4.8 per cent higher but US trading profit, in dollars, was down by 13.2 per cent due to the decline in profits in Stock. US Dollar weakness led to an 8.2 per cent adverse currency translation impact when US results are reported in sterling.
US plumbing and heatingFerguson produced another strong performance with 5.5 per cent organic growth, from its focus on core businesses and the advantages gained from its DC network. Commercial and industrial activity remained strong throughout the year and the RMI market remained robust for most of the financial year. However, there were increasing signs of the RMI market slowing towards the end of the period in response to weaker consumer sentiment relating to the problems in the sub-prime sector and concerns associated with the impact of the deteriorating housing market on the US economy.
Local currency revenue in the US plumbing and heating operations rose by 14.8 per cent to $11,079 million (2006: $9,651 million) with trading profit up by 18.4 per cent to $800 million (2006: $676 million). Organic revenue growth of 5.5 per cent was significantly ahead of the market generally, benefiting from the diversity of the business across waterworks, heating, ventilation and air conditioning, industrial and commercial as well as residential markets. Gross margin was up slightly and the trading margin also improved from 7.0 per cent to 7.2 per cent and is the highest ever trading margin achieved. The higher trading margin reflects the business diversity and the specialist product offering as well as a focus on cost efficiency. Increases in commodity prices, mainly copper, gave rise to one-off profits amounting to around $20 million in the year (2006: $43 million).
Ferguson’s total branch numbers increased by 180 to 1,417 locations (2006: 1,237).
US building materialsThe continued slowdown in the new residential market, which accounted for approximately 80 per cent of the activity in this business, caused a reduction in volumes, increased price competition and also led to significantly lower lumber and structural panel prices. These factors have inevitably impacted on Stock’s financial performance despite an aggressive cost reduction programme. Stock continues to outperform in most of its major markets with a 15 per cent reduction in volumes compared to the 25 per cent average decline in housing starts.
New housing has continued to be a difficult market with housing starts having fallen from an average annualised rate of 2.02 million for the 12 months to 31 July 2006 to an average of 1.54 million this year, with the figure in August 2007 being lower, at 1.33 million. There continues to be significant regional variation with the markets in Utah, Idaho, Texas and the Carolinas performing relatively better than the weakest markets in the northeast, midwest, Las Vegas, Colorado and Florida.
Canada C$m
In local currency, Stock’s revenue was down 13.4 per cent to $4,596 million (2006: $5,305 million) with trading profit down 74.9 per cent to $86 million (2006: $343 million), after charging the previously announced one off costs of $22 million relating to branch closures and headcount reductions. During the year, there was a reduction of around 3,500 people, representing approximately 20 per cent of Stock’s total workforce. The decline in organic revenue in the year was 24.2 per cent, reflecting the 15 per cent fall in volume and commodity price deflation in lumber and structural panels, which fell 20 per cent and 24 per cent respectively. The deflation in commodities, which account for around 43 per cent of Stock’s revenue, had the effect of reducing local currency revenue by $470 million (9 per cent). Acquisitions contributed $577 million (10.9 per cent) to revenue growth.
Stock’s gross margin was slightly lower due to pricing pressure in the difficult markets. The trading margin declined significantly from 6.5 per cent to 1.9 per cent, primarily due to lower volumes and prices and the effect of one off restructuring costs.
As part of a cost cutting programme, a number of initiatives have been undertaken including centralising the sourcing of commodity products, headcount reductions and the closure of 46 branches.
Stock will continue with its strategy of diversifying its business to reduce its dependency on the new residential market and expand its presence in the commercial and industrial and RMI markets by a combination of acquisitions and organic growth. The Group continues to believe that the US housing market offers good long-term growth opportunities and Stock will continue to expand its geographic coverage in selective residential markets where value creating opportunities are identified.
As previously announced, there was also a $10 million goodwill and intangible asset impairment provision recorded as a result of market conditions in the Midwest region, where a number of branches were closed. At 31 July 2007, Stock had 308 branches, although, following the previously announced closure plans, its branch network going forward will comprise 287 branches across 33 states (2006: 314 branches).
Wolseley CanadaIn Canada, although housing markets held up reasonably well and economic activity remained positive, business from the oil and gas exploration industries in Western Canada was weak for most of the year as a result of warmer weather, lower natural gas prices and higher gas inventory levels.
Against this background, Wolseley Canada’s local currency revenue increased by 2.1 per cent to C$1,357 million (2006: C$1,330 million and trading profit increased by 0.7 per cent to C$92 million. The trading margin declined slightly to 6.8 per cent (2006: 6.9 per cent) reflecting the initial start up costs of the new regional DC in Oakville, Ontario.
Branch numbers in Canada were increased by 14 to 260 (2006: 246).